Fortress Investment Group Q2 2007 Earnings Call Transcript

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Fortress Investment Group LLC (FIG)
Q2 2007 Earnings Call
August 14, 2007 8:00 am ET

Executives

Lilly Donohue - IR
Wes Edens - CEO
Pete Briger - President and Head of Hybrid Hedge Fund Business
Mike Novogratz - President and Head of Liquid Markets Hedge Fund Business
Dan Bass - CFO

Analysts

Robert Lee - KBW
Prashant Bhatia - Citigroup
Marc Irizarry - Goldman Sachs
Michael Hecht - Banc of America
Roger Freeman - Lehman Brothers
Mathew Fischer - Deutsche Bank

Presentation

Operator

Good day everyone and welcome to today's Second Quarter Earnings Call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the call over to Ms. Lilly Donohue. Ms. Donohue, please go ahead ma'am.

Lilly Donohue

Thank you, Rufus. Good morning everyone, I would like to welcome all of you to Fortress's second quarter earnings conference call. Joining me today; Wes Edens, our Chairman and CEO; Pete Briger, President and Head of our Hybrid Hedge Fund Business; Mike Novogratz, President and Head of our Liquid Markets Hedge Fund Business; and Chief Financial Officer, Dan Bass. We also have with us today Randy Nardone, Chief Operating Officer, as well as Rob Kauffman, who is President and Head of our European Investment Operations.

Before I turn the call over to Wes, as the operator mentioned, this call is being recorded, and the replay number is 888-203-1112 from within the United States, and 719-457-0820 for international callers with an access code of 5147877. This call will also be made available on our website, www.fortress.com.

I would also like to point out that statements today which are not historical facts may be forward-looking statements. Our actual results may differ materially from the statements and expectations in our forward-looking statements. These statements represent the company's beliefs regarding events that, by their nature, are uncertain and outside of the company's control. I would encourage you to review the forward-looking statement disclaimer in our quarterly earnings release, including a recommendation to review the risk factors contained in our annual and quarterly reports filed with the SEC.

Now, I would like to turn the call over to Wes Edens. Wes?

Wes Edens

Great. Thanks, Lilly, and welcome everyone at the break of the day here on Friday. Welcome to our second quarter earnings call. It's our first full quarter as a public company, and we had a terrific quarter to report in, both in terms of earnings and asset management growth and of course, dividend.

Before I talk about the specific results and then give you some thoughts on the different businesses, I am going to spend time on both the private equity as well as the castles, and then have Pete talk about his credit businesses, and Mike, the macro business. But before we get to that I thought I’d take a step back and give you a little perspective on what's been going on in the market just given all the turbulence and volatility that we have seen.

In times of prolonged low volatility, which is really what we have had for the last number of years, people and markets tend to stretch, and that's exactly what we see happen. People stretch in terms of pricing, they stretch in basic terms and conditions of the investments they make, and then most importantly they stretch in liquidity. And of all the risks that exit and/or impossible really to manage unless you are very, very mindful of it, liquidity is the top of the list.

It is the number one cause of debt in the financial services business when firms make themselves in positions where they need access to short-term financing and they can't get it, and that's exactly what we saw. Our business is an investment business and disrupted and volatile times like this can create terrific investment opportunities, and both myself, Pete, Randy, Rob, all of us have long experiences in the distress market and so these investment opportunities that exists in these markets can be terrific, but first you need the markets to return to a little bit of normality.

There has to be a two-sided aspect to the market. There has to be both buyers and sellers, in particular on the financing side, and that is something which is returning to the market, but there is still exposure we think in the markets right now.

When you look at the different aspects of the debt markets, I really think of them very, very differently. On the corporate side, what you have today is you have a significant amount of debt held in the balance sheets by a handful of large investment banks, financings that are not yet placed from LBOs in particular. And that debt has to be cleared out before they can return to more normalized pricing and end-market conditions.

Our view is that it's largely a price issue and you have got 200, 225, $250 billion of debts that exists in these balance sheets. Price should rectify the situation and we have seen some movement in that regard, but I expect it given what’s happened historically, we would think that this is something that should come to marketplace in the next month or two and then markets would again be more normal.

On the subprime and residential markets, it's a very different story where we see true credit issues that prospectively exists there. On the Newcastle call that I had a week or so ago, I went through some of the specific statistics regarding the performance of subprime and its current vintage versus other troubled times, and particularly the 2000 vintage, which is the last great kind of trouble period in the subprime business. In broad terms, we are talking about losses in those sectors, which are likely to equal or perhaps eclipse the kind of numbers that we had back seven years ago.

This is not something you are going to see manifest itself any time soon, I mean, when losses occur in this sector and people have to sell their houses or get delinquencies and foreclosures like this, is something that tends to plays itself out over long periods of time. And so, I don't expect that the markets are going to return to a normalized state in the subprime sector any time soon. The impacts that we are focused on -- again interested in obviously, is the impact that they will have both on the consumer as well as in the housing markets. So, I think more perspective of those things to stay tuned to -- it's nothing that is going to happen and going to change any time immediately. And I don't expect those markets return to normal.

Happily from our perspective, we have very limited exposure to the sector as an investment matter and do think there could be some terrific investment opportunities that come out of the other side of it. The subprime problems acted as a catalyst in the market disruptions much as the Russian debt defaulted almost exactly nine years ago today.

But obviously, the subprime issue specifically is not the catalyst for some of the spill on effects that we have seen, be it some of the quantitative strategy that have difficult times and the hedge funds over the past week or two, some of the commercial paper issues that exists in the marketplace today. So, I think the market remains vulnerable in the short-term to surprises that could be disruptive. But generally speaking, as investor confidence returns the market should come back to a more normalized timeframe and thus be once again ready for transactions.

The impact on us, in the short-term very modest impacts in term of the fiscal year, in private equity we have no financed acquisitions. We have no short-term liquidity issues at any of our portfolio companies and we have a brand new fund five to invest. So, we feel like we are in a great position in the private equity standpoint.

In the hedge front side of it, Pete will talk just a minute about his business, but Pete is the liquid provider and so at times like this he should be the beneficiary of greatly increased investment opportunities. And we think that is absolutely what's going on in that business.

Mike's business is our most market sensitive sector. Macro had a tremendous first half of the year, as evidenced in the results. He has given back a little bit in the past six weeks or so, but also we think, given the breath and experience in that business, we think that there is a lot of opportunity there.

Castles business, we rely on term financing to fund our businesses on balance sheet, which by the way has always been a good idea. In times like this, it's obvious that is a critical idea. In fact, the folks that you have seen that have really material corporate problems and the subprime and residential sector had by and large been 100% a function of liquidity problem. So, when we look at those sectors, we think that that there are lots of opportunities and we don't have liquidity problems in those businesses and that's great.

Now, the price of many of our public equities that we own has gone down and of course that's a disappointing result in any one period of time. But I feel quite relaxed about the overall businesses because the most important aspect of them of course is the underlying business themselves including our business are doing terrifically, and I find that after these kind of volatile periods pass, things return to what they are worth. And so, without any fore-selling or without any forced liquidations, we feel like we have got great things ahead of us.

So, specifically just talking about earnings for the second quarter and the first half, pretax distributable earnings for the quarter was $143 million, an 86% increase from the second quarter of 2006. Just to reiterate, distributable earnings is our estimate of the cash flow we think most accurate. It reflects what’s come up from financial perspective. It is also the measure that we use to set our dividend.

So, we have a dividend for the quarter on an annualized basis, which equals $0.90 per share based on the estimated taxes and a 75% payout ratio that implies a pretax distributable earnings for the year of about $689 million. So, we feel good about those numbers and I look for a healthy second half of the year.

Assets under management for the quarter ended up at $43.3 billion. So, a very, very substantial increase over the $36 billion at the end of the previous quarter, and $30 billion in the prior quarter. Much of the increase in assets under management was from the private equity business and our new funds of $5 billion came out of private equity. Hedge funds -- also significant contributors at $2 billion.

We have got two new investment initiatives in the firm. First of all, we mentioned this in the press release, but we announced the hiring of Henry McVey. Henry is a very, very talented fellow that was the Chief Investment Strategist at Morgan Stanley. He is coming to set up a group to create a hybrid investment product for us that will basically match the public equities investment business with our private equity business. So, it's a fund that we expect to launch here shortly, and we are very excited about that.

Second of all, [Bill Callahan] joined Mike in the macro business. Bill has got a long track record and a successful track in the commodities business, and we think that the long-term macros -- not to overuse the word macro. After that, that sector in the business is terrific, and so Bill will come in to work with Mike and bring his squad in.

Let me talk just for a few minutes about private equity and the castles, and I will turn the call over to Pete. In private equity, we had pretax distributable earnings of $28 million in the quarter. This was only management fees. We did not have any realizations in the quarter. However, right at the end of the quarter, we sold our stake in Crown Castle, which will generate a significant investment return and you will see that as money flow through in the third quarter.

Assets under management and private equity was up 64% from where it was a year ago. So, we ended the quarter at $23.4 billion, so just over half of our total capital under management, but obviously Fund V was a big amount for us.

Busy investment quarter, we highlighted by the take private transaction of Penn Gaming, this is our first investment in the gaming sector. Penn is about $9.5 billion gaming company based here in the US. It's a slots-dominated business, not in either Atlantic City or in Las Vegas. We think long-term trends in that sector are significant. So, we are very delighted to be an investor in them.

And then also in July, we closed on two public take private. The Florida East Coast railroads, which is a combination of a railroad and a real estate business, as well as Interpool. Interpool is our latest addition to our shipping and transportation business. So, in fact, we are going to combine all those things together -- our shipping operation our container business and then this, the chassis business.

So, if you look at the total surplus that we have got, it was a tough quarter on a mark-to-market basis and then the number of the stocks were down, but we own at quarter-end about $10 billion in public stocks for the cost basis just under $5 billion.

On the private side, we have got now a total of $11.7 billion of private capital invested. So, the amount of capital that should realize substantial investment returns of things come to pass in the future that $11.6 billion is up substantially from the beginning of the year. We have had $5.4 billion in capital invested. So, it's been a very, very productive investment period for us.

And most importantly, I think the quality of investments is very high even with the disruptions to the marketplace, if I can go back and make these investments and analyze them today versus where they were from a month or two ago, I would be delighted to make investments. So, we love these companies and I think they have got a lot of promise.

On the castle side, in Newcastle we've raised capital back in April $125 million, which now looks like excellent timing. This is the sector that’s really been the most harmed in the short run by the volatility. Newcastle itself has a terrific balance sheet, but the bad balance sheet companies are basically going out of business there. The key to making money in distress market like this is to move as quickly as possible to go from defense to offense. That's exactly what we are doing inside that business. So, we will see how it plays out here over the next weeks and months, but I think the opportunity set for Newcastle is better today than it has been any point in recent years.

Eurocastle we had a traffic quarter, it’s interesting, there is a big disconnect right now between what's going on in the ground in Germany in real estate business and what is happening in the public priced at stock. But the real estate businesses, the economy in Germany has been very strong. We own the biggest office company that’s listed over there, great assets, or great leasing, great prices. So all that's going terrific and of course, the stock price is down.

So, higher interest rates in Europe will contributed to lower prices across the whole real estate sector, but again we are in a good position there and we feel really terrific about it. So that's some of these businesses.

With that I would like to turn it over to Pete.

Pete Briger

Thanks, Wes. First the numbers for the second quarter for hybrid hedge funds. Pretax on distributable earnings were up 66% to $28 million versus $16.9 million for the second quarter last year. Total revenues were up 58% to $70 million from $44 million, the same quarter last year.

Management fee is up 64% to $31.7 million from $19.4 million due to significant assets under management growth. Incentive fee is up 53% to $38.3 million from $25 million due to higher assets under management and higher returns.

Total expenses including profit sharing compensation is up 71% to $52.4 million from $30.6 million a year ago. Expenses are higher due to growth in headcount to support our overall business, up $14.7 million or 77%. And increased profit sharing expense of $7.2 million or 62% due to higher incentive fees.

Total assets under management including committed capital are up to a little over $8 billion up about 100% from $4.1 billion a year ago.

The numbers for the six months ended June 30th for our hybrid hedge funds. Pretax distributable earnings were up 88% to $71.7 million versus $38.1 million in the last year. Total revenues are up 62% to $145.1 million from $89.5 million for the first half of last year. Management fee is up 69% to $60.7 million from $36 million due to assets under management growth. Incentive fee is up 58% to $84.4 million from $53.5 million due to higher assets under management and higher returns.

Total expenses, including profit sharing compensation, is up 65% to $95.8 million from $58.2 million a year ago. The expenses are higher due to growth in headcount to support the overall business and increased profit sharing expense due to higher incentive fees.

Fund performance for the second quarter, net return after management incentive fees was 3.37% versus 2.7% last year. And fund performance for the first half of 2007 was 7.94% versus 6.58% for the same period last year.

I want to talk a little bit about the market and how it relates to hybrid hedge funds.

The financial markets are in the midst of liquidity crisis, as Wes mentioned, and certainly the residential mortgage market has entered a period of all out free fall, and investor shutdown. The market's recent lack of confidence in CDO and CLO structures across the board has caused debt to reprice, and we will continue to waive on debt spreads and asset evaluations generally for the time being.

Volatility is by any historical measure very high, and these factors will all be positive in terms of returns and transaction flows for our special opportunities business.

The current market for hybrid hedge funds and special opportunities in particular is characterized by, on the one hand, more perceived danger, and on the other hand more real opportunity.

Prejudgment, with respect to asset liability management and emphasis on the fundamentals over the medium and long term, will make the current investment market for all assets and credit investors look good in hindsight.

Please note, I said good not great. Most of today's opportunity is a function of liquidity not subsidiary of credit concerns. If the investment climate was two out of ten earlier in the year, today it has moved to about six and ten for hybrid hedge funds.
In terms of hybrid hedge funds, we are very well situated to capitalize on the current environment and should further deterioration occur. Special opportunities' current leverage is relatively low at 0.3 to 1, as a percentage of net asset value with less than 1% of net asset value financed through short-term repo.

Special opportunities as available term non-recourse debt financing through its financing counter parties of several billion dollars and un-drawn capital commitments of over $750 million.

Fortress Partners Fund's leverage is also extremely well at 0.2 to 1 of net asset value. And Fortress Partners Fund has access to debt capital through its committed financing line of approximately $300 million with no short-term debt.

In summary, while the current environment makes it harder to create earnings in the short-term, liquidity crisis is an opportunistic lender and asset buyer's best friend. Mike?

Mike Novogratz

Thanks Steve. The liquid market business had an exceptional second quarter. Pretax distributed earnings were $79 million and revenue of $151 million. Management fee is $38 million, incentive fee $113 million. That came from 8.8% gross second quarter return.

And for the year in net terms at about 10.5% for the first six months. We raised a lot of capital in the second quarter taking the fund up to $7.4 billion, that's a 71% increase from a year ago. That makes $1.75 billion for the fiscal year on the first half of 35% increase.

We've done a lot to bolster our business in the second quarter as well. We opened London as a liquid market trading center, a second one. We hired four new portfolio managers including, let’s say, Bill Callahan into a commodity business. We got rated by Moody's. Moody's gave us the highest operational rating in Q1, rating both the back office and in-house.

But the second quarter is past and I'm sure most of you guys are more focused on the third quarter. So, I'm going to spend a little time focusing on that.

Just to start with the numbers was in the fund loss 1.9% in July and are roughly down that much in August. We reduced risk to 35% of pre-crisis levels. The cash or available liquidity is up 29%.

Our broad idea is that there was a paradigm we've been investing in for the last 50 months. One that was marked by bundle of liquidity nearing with premiums and (inaudible) long assets. That shifted five and a half weeks ago. And what I've learned in the macro business is when the river bends and when the paradigm shifts, the first stop is to the sidelines to raise cash, to shrink the balance sheet.

I think over the next 2 to 12 weeks, the new paradigm that we are investing in is going to merge from the Macro guys. And we are well positioned to take advantage of both trading and investing opportunities. So, that's it. Dan?

Dan Bass

Thanks, Mike. As Wes, Pete and Mike mentioned earlier, we had another successful quarter, our first full quarter as a public company. A number of our key performance metrics have grown significantly during the quarter, which I will focus on today.

First, growth in our assets under management including management fee assets under management, second growth in distributable earnings and our cash dividend. Finally, our investing and financing activities during the quarter highlight the expansion of our global financing and our ability to fund the growth in our businesses.

As mentioned previously, assets under management as of the end of second quarter totaled $43.3 billion up 70% from a year ago, and management fees paying assets under management totaled $28.6 billion up 68% from the year ago.

Each of our segments significantly contributed to the growth of management fees paying from the management, as follows. Our private equity assets under management group primarily due to the raising and divesting of a handful of private equity funds, including as Wes mentioned, the recent close of our private equity fund V and fund V current investment funds, have together raise $5 billion third-party capital in the second quarter and the Drawbridge real asset funds which raised 300.

Growth in our Hybrid Hedge Fund business, management fee paying to the management of 73% due to significant capital raises during the past 12 months, establishment of Fortress Partners Fund in the third quarter of 2006 and positive fund performance as Pete mentioned over the past year.

Growth in the liquid hedge fund management fee paying AUM was 71% primarily due to significant capital raises over the past year including over $1.7 billion since the beginning of 2007, as well as positive fund performance for the same period. As well as Wes mentioned, capital raises in New Castle in the first half of this year, and Eurocastle in the fourth quarter of 2006.

As I explained in our first earnings call, distributable earnings is a supplemental measure of how we manage and evaluate our businesses and their operating performance. We also use it to measure earnings available for periodic distributions to shareholders. Distributable earnings is a non-GAAP measure, and we have reconciled it to our GAAP earnings in our 10-K and our press release.

The second quarter of 2007, our pretax distributable earnings was $143 million up 86% versus the second quarter of 2006. For the first half of 2007, our pretax distributable earnings was $363 million, up 89% from the same period a year ago. Pretax distributable earnings per dividend paying share of $0.33 for the second quarter which is up from $0.21 in the equivalent second quarter of 2006, a 57% increase.

During the quarter, we also declared our second quarterly dividend as public company paying a dividend of $0.225 or $0.90 on an annualized basis, a 32.4% increase over our pre-IPO annualized dividend of $0.68.

Significant component to distributable earnings is segment revenues, which increased to $283 million for the second quarter of 2007, a 50% increase from the second quarter of 2006. Segment management fees for the quarter were $45 million, 62% greater versus the same quarter, primarily due to the capital raises mentioned above.

Although no incentive income was received from private equity funds during the second quarter, incentive income for the six months ended 2007 increased by $223 million versus the same first half of '06, due primarily to realization events in the first quarter of this year.

As Wes previously mentioned, our private equity funds recently sold all their shares in Crown Castle, generating approximately $56 million in private equity net incentive income, which will be recognized in the third quarter of this year.

In our hedge fund business, positive fund performance contributed to the increase in segment incentive income of $110 million or 268% increase in the second quarter versus the same quarter of last year.

Segment expenses increased by $52 million due to greater profit sharing comp expense, headcount growth in all of our business lines as well as continued investment in infrastructure as a result of being a public company.

Accordingly, as it relates to our operating income margin, which were 48% for the second quarter and 51% for the June year-to-date results, any quarter's margin will be affected obviously by the overall level of incentive income recognized during that quarter. We believe that our operating income margins over time should be generally consistent with these margins, and the margins that we earned historically.

Lastly, with respect to our investing and financing activities during the second quarter, we expended our credit facility to $1 billion on more favorable terms in May of this year including lowering our costs of borrowing. Of this facility, approximately $640 million remains available to be drawn for investing and/or liquidity needs.

During the quarter, we made new commitments to our funds of $385 million, inclusive of $275 million commitment to co-investment firm which invested and I announced, Florida East Coast Industries' transaction. That deal closed in July of this year.

In summary, as we have now completed our first quarter as a public company, we are pleased with our performance in the second quarter as well as year-to-date.

Now, we will open it over to Q&A.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). And for our first question, we go to Robert Lee with KBW.

Robert Lee - KBW

Thanks. Good morning. Just a couple of quick questions. I am just curious and maybe this is more a question for Wes, but given the current environment, what kind of changes are you seeing, if any, in sort of solid behavior in the investments you are looking at in private equity?

Wes Edens

Well, I think it's too early to tell kind of what the changes in behavior are going to be. I think that clearly, it's difficult to transact right now. So, I don’t expect to see a lot of buyer activity in the next month or even two until the debt markets return to a more normalized pattern. But these are the types of things that tend to make people more focused on actually getting something done and less focused on the absolute price point of it. And reduced levels of debt also contribute to better pricings for assets.

So those are the positive things we would expect to see. There's nothing in the short-term, not that we have seen in terms of real panic or anything else. If private equity transaction doesn’t happen in a week or even at five or six weeks, it takes longer periods of time. So it will be something which we will see play out I think in the next month or two, Robert.

Robert Lee - KBW

Okay, and a question for both Pete and Mike. I am just curious, since the start of the quarter and in the midst of this, I mean, can you give us some color maybe on -- if you are seeing your clients actually viewing it as an opportunity and seeing pretty decent new money flows until at least hybrid product or maybe tell us a little bit about the kind of reaction you are seeing from your investor base?

Pete Briger

Well, that’s a good question. This is Pete. We anticipated that this credit re-pricing would occur, hence we went to our investors I don’t know, about 6 months ago, and we raised some committed capital so that we wouldn’t have to worry about whether or not they saw it as an opportunity.

Since the markets have changed we’ve had many calls from foreign investors wanting us to take their capital to start new funds, etcetera. And I think that we’ve had those discussions really every day for the last 45 days as to whether or not we should start specialty funds to take advantage of this. But I do think that our current fund Special Opportunities is very capable of handling the current opportunities and we think we are very well positioned.

Mike Novogratz

In the liquid market business we have seen no redemptions thus far. I think all investors in general are nervous, the European fund-to-fund businesses are trying to figure out the extent of their portfolio damage if any. July in general for the fund-to-fund business was a decent month actually it was roughly down 0.5%. So really August has been the month where you have seen the broader dislocations.

We kind of prepare for the worst and hope for the best and so part of our raising cash and lowering our own leverage is just in the case we see redemptions not because of our fund, and so we lost money one month in the last 24 months before this and we have a pretty diverse and big investor base. But if our investors lose money at times they will take money from us. And so, while we don’t anticipate it, we are prepared for it.

Robert Lee - KBW

Okay. And maybe this a follow-up for Pete. Could you just repeat some of the leverage metrics for the hybrid hedge fund, I think I missed some of them when --?

Pete Briger

Sure. 0.3 to 1 for Special Opportunities fund and roughly 0.2 to 1 for Fortress Partners fund. So, any traditional metric of a hedge fund or a finance company these are basically unleveraged funds.

Robert Lee - KBW

Okay. Great. That was it. Thank you.

Operator

We go next to Prashant Bhatia with Citigroup.

Prashant Bhatia - Citigroup

Hi, the unrealized gain in a public portfolio -- what is that now, is that roughly 3.5 billion?

Wes Edens

I don’t have the numbers on a mark-to-market basis in front of me, it's at the quarter end and the price is down, so around a bit, but it was about $5 billion at quarter end. I think it’s maybe down a little, maybe it’s $4.5 or $4.75 billion as we sit here today, but it’s plus or minus I think where it was around at the quarter end.

Prashant Bhatia - Citigroup

Okay. And in terms of -- you talked about the leverage on the hybrid, I think being 0.1 and 0.3. What is that normally, if you look back over the last 12 months?

Pete Briger

I would say that it is roughly consistent over the last 12 months. Since we've been in business we've been net cash, so no leverage to potentially a little bit higher in terms of our leverage. We tended to not to take on leverage unless we saw great opportunity in the marketplace. As I said, the current opportunity is getting increasingly better.

Prashant Bhatia - Citigroup

Okay. And on the liquid hedge fund side, what kind of leverage was utilized during the quarter?

Wes Edens

It’s hard to measure leverage in a simple way when you talk about the macro hedge fund and the liquid market hedge fund. I can buy 100 treasury bills or 100 30-year bonds and would have the same amount of leverage. So, our first measure is volatility. We typically run at 8% volatility or VAR, and that’s been dropped now to 3.5%.

The other way we measure leverage is our net long equity exposure, which was roughly running between 50% and 70%, which is down to 15%, and our gross equity exposure, which was kind of as high as 170% is currently about 75%. And so, in broad strokes I would say, we’ve got to cut leverage in half or a little bit more than half.

Prashant Bhatia - Citigroup

Okay. And on the liquid side, including the performance in July and August. One, is there a hurdle in that fund? And if we include the July and August performance, where are we relative to that hurdle?

Wes Edens

Well, we clip promotes quarterly. And so, at the end of the second quarter, we clip promotes, and so yes now in the third quarter for us to get incentive fees we need to make back the money we’ve lost in July, and the money we’ve lost in August. So, roughly a little bit shy of 4%. We still take the management fee and so as opposed to an annual high watermark, we have quarterly high watermarks.

Prashant Bhatia - Citigroup

Okay. And what is that in a liquid side?

Wes Edens

It’s zero.

Prashant Bhatia - Citigroup

Okay. So, you’ve got to get back. So, there is no hurdle per se, just needs to be positive?

Wes Edens

There's no hurdle, that's right.

Prashant Bhatia - Citigroup

Okay. And the $8 billion on the hybrid side, can you just give us a rough idea what percentage of those assets are actually marked to a market price where available and obviously what present are not?

Pete Briger

Well, everything in the portfolio is independently valued. Everything that can be valued by the broker/dealer community, the commercial banking community, usually five marks every month. And then anything that is less liquid gets marked on a quarterly basis by an independent S&P government folks, those types of folks and they are giving you value rather than a mark.

Prashant Bhatia - Citigroup

Okay. And then just can you remind us on the revenue streams related to the Castles. We see the stock prices down 15% to 30%, just can you walk us through what the impact on the revenue streams are related to the stock price?

Wes Edens

The revenue streams and the Castles are unaffected by market prices. It's a function of the performance of the underlying business or should I say, the business themselves have been great. So we get management fees on capital and a performance fee above the hurdle in the case of Newcastle it was 25% over 10%, in the case of Eurocastle it was 25% over 8% in addition to 1.5% management fees for both of those.

So we are granted options as part of capital formation for those vehicles, obviously the options are less viable today than they were six weeks ago, but that’s a modest overall percentage of the economics. So it's really a cash-flow based set of revenue streams and those cash flows have been quite robust.

Prashant Bhatia - Citigroup

Okay. And then just finally on the private equity side, I think you said roughly $23 billion right now. How much of that is dry powder, how much of that is totally uncommitted that you could put to work?

Wes Edens

Well, we disclosed $5 billion fund that is largely uncommitted. And then what we have done and as just operating matters when we found substantial investment opportunities, we have raised sidecar funds for each one of them. So, the Florida East Coast Railroad is a good example, as part of that acquisition and we raised just $986 million sidecar funds in addition to the capital and the private equity fund.

So one metric to look at is the X billions to dollars in fund V, which is uncommitted, I said most of it is uncommitted now. And then in addition to that, we think we will continue to have access to other capital to the extent we find investment opportunities, which I think is a reasonable chance.

Prashant Bhatia - Citigroup

Okay, great. Thank you.

Operator

We go next to Marc Irizarry with Goldman Sachs.

Marc Irizarry - Goldman Sachs

Great, thanks. Hi everybody. Wes for you on the private equity side of the business for the capital that’s committed, but maybe as we put it to work at, can you just give a little bit of color in terms of what your LP investors expect, sort of returns to look like going forward? And then also, what are their expectations in terms of putting that capital to work, i.e. when are you going to put that capital out? Thanks.

Wes Edens

Well, we tell people on the private equity side our goal to our investors is to deliver kind of 20 plus percent net returns to two times the invested capital. And historical returns have been substantially higher than that, I think that this public numbers are kind of 40ish percent net returns historically. I see no reason why returns today and then certainly in the future can't be consistent with what they have been in the past. Those are lofty objectives, but there is lots of interesting stuff going on both here as well as overseas.

We raise capital in the private equity funds, we try and size the funds to bear what we think we can invest in a relatively short period of time. So, as opposed to raising much larger private equity funds what we’ve done is raise more modest funds capping them actually. And then, as we found incremental and investment opportunities going back to LPs and invested it.

So, fund for took about a year and a half roughly to invest a little bit less than that. So, obviously the investment activity was higher there. Actually, if you take kind of mid-point of 2006 to mid point 2007, it was a very prolific investment period for us. I think total equity investment was just a shade under $10 billion.

So, again if you stack bid up versus other kind of large private equity firms, whether they are Blackstone or KKR, whoever those are, numbers that are probably consistent with the investment activities amongst the bigger folks. And yet, we don’t have the single monolithic fund to invest. But I’ve a preference for these smaller kind of more agile investment products.

So, expectation wise, I think people expect us to get the capital to work for them in the next couple of years. And once the market settles down a little bit here, I think you could see some terrific opportunities.

Marc Irizarry - Goldman Sachs

Great, and being a fund sizes that are generally smaller ought to help you in this environment?

Wes Edens

I don’t think, I mean, what we’ve done as an operating matter is made fewer kind of larger investments in the last number of years, and we’ve made kind of more concentrated investments. We make them in asset-based and kind of cash-flow based businesses. So, we don’t think that having larger investments necessarily creates concentration of risk in the same way that it might if we are investing in more cyclical or industrial types of investments.

So, investing in things like the railroad company we just bought, like the gaming company, which I am very excited about it. There is a lot of interesting work still to be done in that sector. We made larger investments because that allows us to concentrate the right amount of resources and what not, and kind of bring focus to bear on them.

And I think that has been a sweet spot for us or probably our average investment in the past year, I [ought] to manage it’s been North of $1 billion. So, they are not small investments by any measure and that’s the size that we are comfortable with.

Marc Irizarry - Goldman Sachs

Great. And then Pete, a question for you on the hybrid business. Can you give a little color on your returns to-date? And then also it looks like the management fee net of operating expenses was actually negative, and you mentioned some costs, I guess, some higher costs etcetera. But how should we think about the net management fee going forward? Thanks.

Pete Briger

When you say returns, are you talking about since the end of the second quarter?

Marc Irizarry - Goldman Sachs

That’s right. And then also, I think you characterize this environment as being kind of a 2 out of the 10. When do you think we are going to get to the kind of and meanwhile 6 to 10 now I guess, you said. What's your kind of prognosis on getting to 10 of 10? Thanks.

Pete Briger

Well, I will have to answer that last question first. It’s very difficult for me to get excited period. So, getting to 10 out of 10 is very difficult, 6 out of 10 is pretty good. And so, going from 6 out of 10 from 2 out of 10 is a big move. You have the liquidity crisis. I like liquidity crisis as long as I’ve been diligent about lining up my financing, and making sure that we are correctly positioned, and we are correctly positioned.

I think returns since June have been very good on a relative basis. We are up in July. The numbers are not to my investors, yet. So, I don’t want to be more specific on that. And we’ve been short in hindsight and would have loved to have been a lot more short, but if I could drive in the rearview mirror all the time then I guess it would look a lot better, but things are pretty good.

From a return perspective and I think what we are mostly proud of in this market is to have so much locked in term financing, because that is a variant of being short if you look at our net interest margins, we want to go out and buy senior stuff go up a lot and that term debt is actually in excess of 10 year term debt so we have a lot dry powder.

In terms of the margins of my business quarter-to-quarter, as you can imagine hedge funds were not necessarily set-up for quarterly or monthly reporting in any sort of smooth manner, but as we hire people later on in the year when you have to amortize their hiring costs over that shorter period of the year, and so that is one issue that effects how the management fees work.

And then the second thing is, if we have good returns in one quarter and less good returns in another quarter that affects incentive fees. In the first quarter of '07 we had a realization of one of our side pockets which affected us positively which we don’t have this quarter and so those are erratic sporadic events.

But generally I think things are going well and as we increase the size of fund minus not a scaleable business, so I can’t just increase the size of my positions, I have to increase the size of the team, the team is very strong and I would imagine that the margins would pick-up over time, if we were to stay at a similar asset size, but as you go into a bigger asset size you are adding people.

Marc Irizarry - Goldman Sachs

Okay. Thanks.

Operator

We'll go next to Michael Hecht with Banc of America.

Michael Hecht - Banc of America

Good morning.

Wes Edens

Good morning.

Michael Hecht - Banc of America

For Wes many of the portfolio companies that are public kind of continue to come under pressure and maybe just touching on one of the -- two of the largest ones like Gag or Brookdale, or maybe some of us would like to hear from your perspective what you think is driving some of the weak performance and give a little color on how you see maybe the business is trending versus how the stocks are doing in? And does this have any impact on the realizations or incent fee income you expect to generate in second half of '07 versus maybe what your prior expectations were?

Wes Edens

Well, in our current base case forecast that we use to set our earnings estimate and our dividend, we don’t forecast, we need for liquidations in the second half this year, notably before this disruption. So, the short answer to your second question is, no we don’t see any meaningful impacts. The Crown Castle sale which is originally our global signal company that we have swapped in the start for Crown Castle. We sold that right at the end of the second quarter those numbers will come through for the third quarter.

Our business on the private-equity side is a lumpy business, and so we don’t really think about it from quarter-to-quarter but more over the course of the year, and I feel like where we are right now is a great time.

The businesses really across the board in private equity side, I have a lot of affection for it, I think we have great businesses and a great squad of people that are doing them and their investment opportunities are terrific. Gags are -- on an absolute basis -- has done fantastically, they are going to have an earnings call here in a few days. We can hear from the horse’s mouth, sort of speaking in terms of the performance of that company, but the underlying fundamentals of the business are terrific, and we don’t control the share price obviously and so we can focus on as the performance has been great, you know Brookdale I still think is one of the greatest really organic investment businesses we have ever invested in. The underlying fundamentals like demographics what impacts seniors and their need for housing existed before July 1st and they exist today. So, there has been nothing really in the short-term that has really caused that to go sideways at all. And then, we haven't changed our kind of targets for those companies or our prospects for kind of liquidations so, we feel pretty good about that actually.

Michael Hecht - Banc of America

Okay that’s fair enough. Another question, can you give us a sense of any exposure to some of the issues we have been reading about the asset-backed commercial paper markets and I guess there was an article in the press suggesting you guys had some issues you maybe rolling some of your ABCP paper, I mean any sense of the assets that are kind of housing your conduit?

Wes Edens

Yeah, I can, I will speak from the first in terms of the funding issues as many of the companies we have very negligible exposure to it; we haven't used it as a primary source of financing in any of our business. I think in Newcastle we have an asset-backed commercial paper that was outstanding but it financed agency security. This is not a meaningful exposure to us and obviously the repo markets sort of financing for those markets are totally -- actually available and fine. I think on the investment opportunity side maybe Pete, I thought about that.

Pete Briger

Well, I think that there is significant risk in the asset-backed commercial paper market particularly just in that the given liquidity crisis that we are in had led to prices for the underlying securities that back those commercial paper conduits and commercial paper programs being upside down for really the first time ever. And so, I would expect a lot more carnage in that area with an investor base that really doesn’t expect to have carnage, so I see there is an opportunity and certainly we've been getting a lot of phone calls lately now.

Michael Hecht - Banc of America

Okay. And then, do you guys have any updated thoughts on just some of, where we have kind of tax proposals out there and kind of expectations for changes to tax-rate guidance and so?

Wes Edens

We obviously had a lot of questions about that. We've spent a fair bit of time internally trying to understand what the positions actually are. I think the short answer is that we don’t think anything is going to happen any time soon. I'm not in a position to know what the right tax rate is.

I do think that people need to be thoughtful and mindful of the unintended consequences of just escalating one piece of tax on one particular business and what the spillover effect could be in other areas and I think that, that's exactly what's happening in Washington as the people have made simplified statement about tax policy and then, if you get down to really going through the mechanics of trying to implement that into a piece of legislation it gets more complicated.

So, I don’t think anything is going to happen any time soon. I don’t expect it will change our behavior anyway, which is obviously the most important aspect. We pay our taxes as they are calculated and we don’t do a lot of fancy work with respect to trying to do anything about that, and I think it's pretty much of a wait and see.

Michael Hecht - Banc of America

Okay. And just last question, I know it's still kind of early but can you talk any more about the relationship into more how that often an investment idea perspective or distribution or any of the close you are seeing coming from relationships opened up to that kind of relationships and more?

Wes Edens

Sure. I think it's early days. I think that we see some distribution for Fortress being built for the Nomura relationship. We've hired a couple of folks in Japan and we’re early days in our business there, although the principles of Fortress have a significant amount of experience in investing in Japan and Asia.

I think the environment in Japan is a reasonable one, maybe a little bit than six in terms of my view of the investing climate there right now. But I think the Nomura affiliation will be very positive to that as we begin investing in Japan and investing in the Asian region.

Michael Hecht - Banc of America

Okay. Great. Thanks a lot guys.

Operator

We go next to Roger Freeman with Lehman Brothers.

Roger Freeman - Lehman Brothers

Hey, good morning. Wes, I think at your Analyst Day couple of months ago you mentioned that you expected to IPO a couple of portfolios companies by the end of the year as you are thinking about that change in all given the current environment?

Wes Edens

Not at all. We’ve got and obviously would be a challenge to get an IPO done today, but I don’t think that today is necessarily representative what the market will look like in the second half of the year. We’ve got our time business which is a bank and finance and real estate business which we have been spending some time on, and then we've got another one of our large complexes here in United States that we are working on.

These are not yet public offerings, so I want to be careful about what I say, about either one of them. But they both are substantial operations, we think both have great prospects and will do -- you all received in the capital markets this year. So, timing-wise expected those are both probably fourth quarter events, just making the papers in process to get into the regulatory processes takes some time.

We don’t have -- one of them will be done perspectively in Europe, one is done here in the US. Neither of them are on file now but I would expect in the next 30 to 60 days potentially both of them could be filed. So, we will have an update for you hopefully in the next quarterly call.

Roger Freeman - Lehman Brothers

Okay. Do you have any early thoughts on looking at the portfolio going into 2008 where you might be looking to IPO next year?

Wes Edens

We’ve got a couple of I think real prospects -- the life cycle of our businesses is that we tend to buy these things and try to rationalize the almost -- the business can think or are needed to be rationalized. And then in a company and the business where we think there are investment opportunities, we want to get those companies public to get access to lower cost capital and take advantage of that.

I do have a couple of very specific thoughts about our businesses which that we think would benefit from being public and again absence some kind of cataclysmic market conditions which frankly, I don’t think is the expected case I think we will continue to be active in this markets so.

Roger Freeman - Lehman Brothers

Okay that’s helpful. And Wes as you think about the, sort of the current environment now, do you think there is risk that you will find more competition among smaller deals where you tend to focus as some of the other firms are unable to do bigger deals and maybe redirect their focus in smaller companies as well?

Wes Edens

We don’t -- I think it has less to do with the size of the transaction, more than nature of the transaction. We are focused again are these kind of asset base cash flowing investments. And for whatever reason, probably a number of good ones, those tend not to be the primary slaughter for investment product for some of the other, the other large private equity funds.

So, we haven't seen significant amounts of competition from restart that group of investors over time. And I don’t think that’s going to change by virtue of the lack of availability of debt kind of forcing those guys to look at smaller deals at all. I mean, as a general rule, all deals have been much less financed than a lot of the other transactions. If you think Florida East Coast, which we just as private is about $3.5 billion oil on purchase price. We put in across all the different funds just a shade over $2 billion in equity.

So, we tend to finance our stuff much lower leverage than the other folks do. We also tend to use the asset-backed market eventually to finance ourselves, which again when you look at these very disrupted periods of time access to corporate credit can be challenged. And in virtually every market, you can sell AAAs and AAs, and what not, so investment grade securities off of assets. And so, I feel like the environment actually is one that suits our investment style very well.

Roger Freeman - Lehman Brothers

Okay. And as you look at your deal pipeline right now, can you make any comments about sort of regionally how it’s backed up, maybe domestic versus international, Europe/Asia?

Pete Briger

Well, these kind of things tend to go in low cycles, and Europe was very prolific for us a couple of years ago. The last couple of years have been dominated by North American activity. In the pipeline right at this exact moment of time, there is still a very North American-centric pipeline.

Having said that the rise in interest rates and the kind of resulting impact that’s had on prices of real estate and asset based stuff in Europe as well as in United States, I think creates a lot more opportunities. There are things in the street today that I wouldn’t have thought three or six months ago, would had a reasonable chance that they are making a grade from an investment standpoint. Our business is a lumpy business. We don’t try to pick and create diversification. As a matter of principle, it is really about function and the result of the opportunities that exist.

Roger Freeman - Lehman Brothers

Okay. Last question, your employee count went to, I believe, like 700 from 637 at the end of the last quarter. It sounds like there has been hiring in the hybrid space, is that where most of the headcount growth has been?

Wes Edens

Yeah Pete’s business is one where it takes more people to find things, takes more people to process them. So, if you look at our overall headcount changes in the past 12 months, they have actually been largely focused in the hedge funds, both in Pete and Mike’s business, but more in Pete’s I think. Private equity stuff is a pretty scalable business. So, actually headcount there has stayed, they have grown a bit, but they have actually been modest amongst the growth.

Roger Freeman - Lehman Brothers

Got it. Okay. Thanks a lot.

Operator

And for our next question, we’ll go to Mathew Fischer with Deutsche Bank. Mr. Fischer, you line is open.

Mathew Fischer - Deutsche Bank

Hi. Good morning I am sorry. Just one follow-up most of my questions have been answered. With the private equity, Wes, the $5 billion in dry powder, what is there in terms of purchasing power? So, what’s the leverage of the level of leverage that can still be required in the market? And once we get through this credit issue, shall we get through the next couple months? Where does that sort of end up?

Wes Edens

Again the amount of capital we have specifically available today is only one of the metrics in terms of the amount of dry powder so to speak that we have. But all our investments in the private equity space have averaged kind of 50% to 60% leverage. So, in the ordinary course $5 billion would support $10 or $12 billion of purchasing. But that’s a more modest number than probably exist in practice, because we have had access to more capital than that. And we’ve found investment opportunities that we thought were going.

Mathew Fischer - Deutsche Bank

Okay. Where is the, I guess, realization period now in terms of private and public companies? What are we looking at for the life cycle of these investments?

Wes Edens

Obviously, as a public company, we can’t comment about our public stakes, because they are public -- some are our shareholders. We don’t have anything, which we are forecasting or liquidating any time soon. And we do have, we do make kind of targets about realizations once they have hit levels where we think that they make sense to reduce the fund's exposure to them, but there is really nothing on the docket any time soon.

So, I think the activity you likely to see in the near term will be perhaps a number of go publics on some of the private, which will give you some visibility about some of the profitability of those investments. And on the investment side, I think the realization stuff is probably a second half 2008-2009 event for a number of these different investments.

Mathew Fischer - Deutsche Bank

Okay. Great. Thank you.

Operator

And with that ladies and gentlemen, we have no further questions on our roster. Therefore, Mr. Eden, I will turn the conference back over to you for any closing remarks.

Wes Edens

Yeah now I just wanted to say thanks and I know it’s early in the day for everybody here. It's summer time, but it certainly doesn’t feel like the summer right now from a time and work standpoint. And we appreciate all the callers. I know that again the public markets can be volatile, the price bounces around, we are most focused obviously on creating shareholder value in the long run and feel like we had a great quarter notwithstanding the changes here recently, and I feel most importantly that the best time should come I think perhaps this fall. So, thanks very much.

Operator

And ladies and gentlemen, this does conclude the second quarter earnings conference call. We do appreciate your participation. And you may disconnect at this time.

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